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The Bank Plan Cometh

The key details, per the Times:

The plan to be announced next week involves three approaches. In one, the Federal Deposit Insurance Corporation would set up special-purpose investment partnerships and lend about 85 percent of the money those partnerships would need to buy up portfolios of mortgage assets that banks want to sell.

In the second, the Treasury would hire four or five investment-management firms, matching the capital that each of the private firms puts up on a dollar-for-dollar basis with government money.

And in the third piece, the Treasury plans to expand lending through an existing joint venture with the Federal Reserve, the Term Asset-Backed Secure Lending Facility. That program seeks to jump-start the market for business and consumer loans.

Set aside the third component, which is the best understood. (It has to do with the business and consumer loans that get bought up, sliced and repackaged, then sold off to investors. The government is now going to be a major investor so that the loans flow more freely...)

The first component sounds like a (semi-)free-market "bad bank" approach. Under the traditional bad bank model, the government carts away a bank's depressed assets and replaces them with enough money to revive its balance sheet. In this case, the government is providing financing for private investors to buy the bad assets, but the exercise is pretty similar. (According to the piece, private investors may only have to put up about 3 percent of the cash for the transactions.)

The second component seems pretty similar to the first, though with private investors putting up a little more of their own cash. It's not immediately obvious to me why they'd participate in this program rather than the previous one, but the details we have are pretty crude at this point. There's clearly some rationale; I just don't know it yet.

The big problem with the plan is that it's still not clear what the point is: Is it to help the banks, in which case we need to overpay for the assets (because paying a fair price would leave them with huge losses, since the assets are worth much less than they paid)? Or is it to get a good deal on the assets for the taxpayer (and the investors they're funding)? As the Times' notes:

Risk-taking institutional investors, like hedge funds and private equity funds, have refused to pay more than about 30 cents on the dollar for many bundles of mortgages, even if most of the borrowers were still current. But banks holding those mortgages, not wanting to book huge losses on their holdings, have often refused to sell for less than 60 cents on the dollar.

So the two goals seem incompatible--a good deal for the banks is a bad deal for investors, and vice versa. But the Times suggests Treasury wants to accomplish both simultaneously. On the one hand, "the government’s crucial subsidy is meant to provide investors with the kind of low-cost financing" that would induce them to pay more than bargain basement prices. On the other hand: "The key protection for taxpayers, according to people briefed on the plan, is that the private investors would be bidding in auctions against each other for the assets. As a result, administration officials contend, the government will be buying the troubled loans of the banks at a deep discount to their original face value." (This sentence is slightly counterintuitive--it sounds like the point is to bid up the prices--but the idea is that the auction mechanism will help you get a fair price, which will be pretty low.)

It sounds like the hope may be to get the price somewhere in between the 60 cents on the dollar the banks need and the 30 cents investors think the assets are worth. But will that solve the banks' balance sheet problems? I dunno... (I guess it's possible that, with government financing, investors will pay close to 60, but that seems like a longshot.) 

Finally, this is interesting: "The uproar over American International Group’s bonuses has not stopped the Obama administration from plowing ahead." Uh, that's one way to put it. Another is: If you were the administration, would you rather spend Sunday talking about AIG bonuses or your bank plan? Doesn't seem like a bad way to change the subject, assuming the plan was ready to go anyway.

Update: Okay, a bit more detail from the Journal. It sounds like the point of the FDIC-created entity (component 1) is to buy up pools of loans, while the point of the Treasury partnership with private firms (component 2) is to buy up mortgaged-backed securities. (Securities are presumably easier to trade than loans...) Also, the news with the small-business and consumer loan aspect of this (component 3) is that the government will be buying up not just securities made from new consumer and business loans (which it was already doing), but those that were created in 2005 and 2006, which are apparently more depressed.  

--Noam Scheiber